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---

### Overview and motivation
- The COVID-19 crisis prompted large fiscal stimulus programs that pushed public debt to historically high levels across advanced and emerging market economies, with asymmetric increases across euro area countries.
- Post-COVID recovery, surprise inflation, and discontinuation of costly crisis measures have led to stabilization or reduction in debt ratios in some countries, but some countries’ debt remains at levels that raise sustainability concerns, especially as real interest rates are rising and likely to remain relatively higher for some time.
- Elevated debt levels and higher interest rates move debt dynamics into a “danger zone” where liquidity runs are more likely and could morph into solvency problems (Calvo, 1988; Lorenzoni and Werning, 2019).
- The ECB has provided a safety net in the euro area to prevent fragmentation; high inflation today may create tensions between price stability and anti-fragmentation objectives, prompting a new ECB instrument (TPI) whose effectiveness remains untested.
- Core proposal analyzed: a one-off mutualization implemented by a European Debt Management Agency (EDMA) that issues common debt and acquires a fraction of individual countries’ outstanding debt (e.g., debt above the 60 percent treaty threshold or COVID-related debt), with EDMA debt rolled over and no fiscal resource transferred from national to European level.
- Primary mechanism generating benefits: capitalization of a convenience yield on European safe assets; EDMA debt is modeled as risk-free and eligible for ECB purchases.

### Role of monetary policy and fragmentation risks
- Central banks can prevent liquidity runs on domestic debt via temporary interventions coupled with institutional safeguards that enshrine monetary independence and prevent fiscal dominance.
- In the euro area, a single monetary authority faces 20 national fiscal authorities, complicating anti-fragmentation tasks.
- Interaction of ECB policies and national fiscal positions increases urgency of planning future debt reduction strategies, particularly for countries with elevated pre-pandemic debt where debt service could rise.

### Methodology and key assumptions
- Stochastic simulations with serial correlation and VAR-estimated serial and cross-variable correlations were used; shocks are added to the WEO forecast (October 2022 vintage).
- Benchmark criterion: debt-to-GDP is decreasing after the 3rd year of the forecast horizon at a 95 percent confidence level (i.e., 95th percentile).
- Key calibrations and assumptions:
  - EDMA debt is assumed risk-free initially, with an inception convenience yield assumed exactly between German bunds and the weighted average rate paid by individual countries.
  - Interest elasticity of risk-free assets is used to compute the maximum EDMA issuance such that EDMA debt declines as a ratio to European GDP with very high probability.
  - Conservative estimate that interest rates increase by 6 bps for each 1 ppt increase in debt-to-GDP (Rachel and Summers, 2019).
  - No transfers from national budgets to EDMA; EDMA debt is simply rolled over.

### Quantitative results — EDMA safe issuance capacity
- EDMA can absorb up to about 19 percent of euro area GDP in debt without jeopardizing its safe status per simulations.
- Given NextGenerationEU debt is nearly 4 percent of euro area GDP as of 2022, EDMA could issue an additional 15 percent of GDP without hampering euro area debt sustainability at the 95th percentile.
- Sensitivities:
  - Using the 99th percentile as criterion, EDMA could issue an additional 4 percent of GDP.
  - Using the 95th percentile but assuming 0 convenience yield, EDMA could issue an additional 6 percent of GDP.
- Note: increasing safe-asset supply raises rates when interest rates increase with debt level; issuer effects on close substitutes (e.g., Bund yields) are ambiguous and include potential convenience yield improvements from greater market liquidity.

### Quantitative results — National debt dynamics and mutualization scenarios
- Baseline (no mutualization): Most euro area countries’ debt-to-GDP ratios are projected to decrease over the forecast period with 95 percent probability. Exceptions (95th percentile not decreasing after the 3rd year) are Belgium, Finland, France, Italy, and Spain.
- Baseline additional fiscal consolidation required (constant yearly, relative to WEO baseline) to place debt-to-GDP on a declining path with 95 percent probability:
  - Belgium: 2.7 percent of GDP
  - Finland: 1.8 percent of GDP
  - France: 2.1 percent of GDP
  - Italy: 0.7 percent of GDP
  - Spain: 1.8 percent of GDP
- Debt mutualization based on COVID-19 legacy debt:
  - Assumption: the increase in debt-to-GDP from 2019 to 2020 is treated as COVID-related (an upper bound).
  - Estimated increase in debt due to COVID-19: 10.6 percent of EU GDP.
  - EDMA proceeds (15 percent GDP issuance) are sufficient to cover such COVID-related debt reductions.
  - Post-COVID mutualization (95th percentile projections): among the five problematic countries, only Italy’s debt is projected to be on a firmly decreasing path after the debt reduction without additional consolidation; Belgium, Finland, France, and Spain still require additional fiscal consolidation.
  - Additional yearly consolidation required under COVID-debt mutualization (to achieve decreasing debt-to-GDP at 95th percentile after 3 years):
    - Belgium: 2.4 percent of GDP
    - Finland: 1.8 percent of GDP
    - France: 1.8 percent of GDP
    - Italy: 0.0 percent of GDP
    - Spain: 1.3 percent of GDP
- Debt mutualization in proportion to GDP (EDMA issues 15 percent of euro-area GDP and distributes proceeds proportional to individual countries’ GDP, to 10 countries with debt-to-GDP above 60 percent):
  - Results similar to COVID-based mutualization: Italy benefits sufficiently to require no additional consolidation, while Belgium, Finland, France, and Spain still need additional consolidation.
  - Additional yearly consolidation required under GDP-weighted mutualization:
    - Belgium: 2.3 percent of GDP
    - Finland: 1.8 percent of GDP
    - France: 1.7 percent of GDP
    - Italy: 0.0 percent of GDP
    - Spain: 1.3 percent of GDP
- Robustness check: imposing a 50 bp premium on new national debt issuances (to reflect removal of implicit bailout guarantees) erases most improvements in primary balance from the debt operation except for Italy; authors view such a spread increase as conservative.

### Key numerical highlights (preserved exactly)
- EDMA safe issuance capacity: up to about 19 percent of euro area GDP; additional 15 percent of GDP beyond NextGenerationEU (~4 percent) is feasible under baseline assumptions.
- NextGenerationEU debt: nearly 4 percent of euro area GDP (as of 2022).
- COVID-related increase in debt assumed: 10.6 percent of EU GDP.
- Interest-rate sensitivity assumed: interest rate increases by 6 bps for each 1 ppt increase in debt-to-GDP.
- Benchmark sustainability test: debt-to-GDP decreasing after the 3rd year at the 95 percent confidence level.
- Baseline required additional yearly consolidation (95th percentile) for non-decreasing countries:
  - Belgium: 2.7 percent of GDP
  - Finland: 1.8 percent of GDP
  - France: 2.1 percent of GDP
  - Italy: 0.7 percent of GDP
  - Spain: 1.8 percent of GDP
- Required consolidation after COVID mutualization (95th percentile):
  - Belgium: 2.4 percent of GDP
  - Finland: 1.8 percent of GDP
  - France: 1.8 percent of GDP
  - Italy: 0.0 percent of GDP
  - Spain: 1.3 percent of GDP
- Required consolidation after GDP-weighted mutualization (95th percentile):
  - Belgium: 2.3 percent of GDP
  - Finland: 1.8 percent of GDP
  - France: 1.7 percent of GDP
  - Italy: 0.0 percent of GDP
  - Spain: 1.3 percent of GDP

### Lessons from US experience (comparative points)
- Hamilton’s 1790 US debt assumption consolidated state war debts into national debt and accompanied stronger federal fiscal capacity (including exclusive authority to tax international trade); the US later adopted a credible no bailout practice (Congress refused 19th-century bailouts), which supported state-level fiscal rules and discipline.
- Three key differences between US debt assumption and EU proposals:
  1. In the US, state debts assumed were largely for a shared national cause (war); for EU, COVID-related debt is a more natural analogue than pre-union legacy debts.
  2. The US combined assumption with a credible no-bailout constraint and stronger national fiscalization; EU lacks comparable enforcement and ownership structures.
  3. The US assumption was accompanied by nationalization of fiscal policy, whereas the EDMA proposals analyzed keep national fiscal resources unchanged.

### Policy implications and caveats
- Debt mutualization via EDMA could materially improve debt trajectories for some countries (notably Italy) and provide fiscal space for others (Belgium and Spain) but would not substitute for the need for fiscal consolidation and stronger fiscal frameworks.
- Preventing moral hazard is crucial; limiting mutualization to exogenous common shocks (e.g., COVID-19) could reduce political resistance.
- Any serious mutualization proposal must address governance, enforcement of national fiscal discipline, the role of national fiscal councils, potential treaty/legal implications, and banking-union completion to avoid doom-loop scenarios.
- Operational considerations: timing, market liquidity impacts, transmission of monetary policy, and potential ECB offsetting operations require careful design; contingency guarantees and collateral eligibility at the ECB are necessary to preserve EDMA’s safe status in adverse scenarios.
- The analysis is a conservative “zero fiscal resource” feasibility study: it explores how far mutualization can go without national transfers to EDMA; more ambitious designs could assume dedicated fiscal resources or national transfers.

### Conclusions — summary of robustness and fiscal-design considerations
- Under the baseline scenario, for most euro area countries the debt-to-GDP ratio is expected to decrease over the forecast period with 95 percent probability, even without debt mutualization; exceptions are Belgium, Finland, France, Italy, and Spain.
- EDMA can safely absorb up to 15 percent of euro area GDP in debt without jeopardizing its safe debtor status.
- Legacy debt mutualization can help reduce debt levels and enhance public finance sustainability for some euro area countries, but it does not eliminate the need for high-debt countries to maintain high primary surpluses or further increase their primary balance over the forecast horizon.
- Robustness scenario assuming EDMA issuance raises German effective interest rate by 100 bps:
  - Debt dynamics in Germany remain qualitatively similar to the baseline projections, and the effects on German public finances are manageable.
  - Example German WEO estimates and +100 bps scenario:
    - Germany: Est. 2022 = 71.1; 2023 = 73.5; 2024 = 72.6; 2025 = 70.8; 2026 = 69.3; 2027 = 68.2; 2028 = 67.0.
    - +100 bps scenario: 2023 = 74.2; 2024 = 74.0; 2025 = 72.8; 2026 = 72.0; 2027 = 71.5; 2028 = 70.9.
- Feasibility is not the sole criterion; desirability requires safeguards to ensure national debts remain on sound trajectories after mutualization, including strengthening credibility of a no-bailout rule and complementary reforms (e.g., completing the banking union, imposing concentration limits on banks’ sovereign bond holdings, implementing a proper fiscal framework).

### Methodological notes (simulation and thresholds)
- EDMA simulation procedure:
  - Detrend nominal effective interest and growth rates (it, γt) using HP filter with smoother parameter 6.25.
  - Fit cyclical parts to VAR(1).
  - Simulate shocks drawing residuals from a normal distribution with empirical covariance.
  - Use WEO forecast (itWEO, γtWEO) and construct debt-to-GDP dynamics with an interest-sensitivity term where the interest rate is assumed to increase by 6 bps for a 1 ppt increase in debt-to-GDP.
  - WEO forecast extended beyond 2027 by taking 3-year moving averages for forecast variables.
  - Simulation yields threshold d̅EDMA where the 95 percentiles of dt decrease after 3 years.
- Individual-country simulation procedure:
  - Detrend nominal effective interest rate, nominal growth, and primary balance (it, γt, pbt) with HP filter (smoother 6.25).
  - Fit cyclical parts to VAR(1) including lagged primary balance terms.
  - Construct debt dynamics including a nonlinearity term taken from Pamies et al (2021); when adjustment in primary balance is needed, derive a time-constant consolidation amount p̅b by replacing the last term of the debt dynamics with pbtWEO + pbtshock + p̅b.

*Source: WEO Oct 2022 and IMF staff calculations, as presented in the Introduction of wpiea2023059-print-pdf.*

### Introduction

### wpiea2023059-print-pdf - Introduction

### Overview and motivation
- The COVID-19 crisis prompted large fiscal stimulus programs that pushed public debt to historically high levels across advanced and emerging market economies, with asymmetric increases across euro area countries.
- Post-COVID recovery, surprise inflation, and discontinuation of costly crisis measures have led to stabilization or reduction in debt ratios in some countries, but some countries’ debt remains at levels that raise sustainability concerns, especially as real interest rates are rising and likely to remain relatively higher for some time.
- Elevated debt levels and higher interest rates move debt dynamics into a “danger zone” where liquidity runs are more likely and could morph into solvency problems (Calvo, 1988; Lorenzoni and Werning, 2019).
- The ECB has provided a safety net in the euro area to prevent fragmentation (e.g., post-2012 “whatever it takes”); however, high inflation today may create tensions between price stability and anti-fragmentation objectives, prompting a new ECB instrument (TPI) whose effectiveness remains untested.

### Role of monetary policy and fragmentation risks
- Central banks can prevent liquidity runs on domestic debt via temporary interventions coupled with institutional safeguards that enshrine monetary independence and prevent fiscal dominance.
- In the euro area, a single monetary authority faces 20 national fiscal authorities, complicating anti-fragmentation tasks.
- The interaction of ECB policies and national fiscal positions has increased the urgency of planning future debt reduction strategies, particularly for countries with elevated pre-pandemic debt where debt service could rise.

### Rationale for debt mutualization and EDMA concept
- Debt mutualization could enhance public finance sustainability for several euro area countries under key assumptions, notably a favorable interest rate–growth differential (r − g negative) and containable moral hazard.
- The core idea analyzed: exploit latent market appetite for a European safe asset to put national debt on a sounder trajectory via a one-off mutualization implemented by a European Debt Management Agency (EDMA).
- Operational design studied: EDMA issues common debt and acquires a fraction of individual countries’ outstanding debt (e.g., debt above the 60 percent treaty threshold or COVID-related debt), with EDMA debt rolled over and no fiscal resource transferred from national to European level.
- The primary mechanism generating benefits is the capitalization of a convenience yield on European safe assets; EDMA debt is modeled as risk-free and eligible for ECB purchases.

### Methodology and key assumptions
- Stochastic simulations with serial correlation and VAR-estimated serial and cross-variable correlations were used; shocks are added to the WEO forecast (October 2022 vintage).
- Benchmark criterion: debt-to-GDP is decreasing after the 3rd year of the forecast horizon at a 95 percent confidence level (i.e., 95th percentile).
- Key calibrations and assumptions:
  - EDMA debt is assumed risk-free initially, with an inception convenience yield assumed exactly between German bunds and the weighted average rate paid by individual countries.
  - Interest elasticity of risk-free assets is used to compute the maximum EDMA issuance such that EDMA debt declines as a ratio to European GDP with very high probability.
  - Conservative estimate that interest rates increase by 6 bps for each 1 ppt increase in debt-to-GDP (Rachel and Summers, 2019).
  - No transfers from national budgets to EDMA; EDMA debt is simply rolled over.

### Quantitative results — EDMA safe issuance capacity
- EDMA can absorb up to about 19 percent of euro area GDP in debt without jeopardizing its safe status per simulations; given NextGenerationEU debt is nearly 4 percent of euro area GDP as of 2022, EDMA could issue an additional 15 percent of GDP without hampering euro area debt sustainability at the 95th percentile.
- Sensitivities noted:
  - Using the 99th percentile as criterion, EDMA could issue an additional 4 percent of GDP.
  - Using the 95th percentile but assuming 0 convenience yield, EDMA could issue an additional 6 percent of GDP.
- The EDMA issuance limit reflects that increasing safe-asset supply raises rates when interest rates increase with debt level; issuer effects on close substitutes (e.g., Bund yields) are ambiguous and include potential convenience yield improvements from greater market liquidity.

### Quantitative results — National debt dynamics and mutualization scenarios
- Baseline (no mutualization): Most euro area countries’ debt-to-GDP ratios are projected to decrease over the forecast period with 95 percent probability. Exceptions (95th percentile not decreasing after the 3rd year) are Belgium, Finland, France, Italy, and Spain.
- Baseline additional fiscal consolidation required (constant yearly, relative to WEO baseline) to place debt-to-GDP on a declining path with 95 percent probability:
  - Belgium: 2.7 percent of GDP
  - Finland: 1.8 percent of GDP
  - France: 2.1 percent of GDP
  - Italy: 0.7 percent of GDP
  - Spain: 1.8 percent of GDP
- Debt mutualization based on COVID-19 legacy debt:
  - Assumption: the increase in debt-to-GDP from 2019 to 2020 is treated as COVID-related (an upper bound).
  - Estimated increase in debt due to COVID-19: 10.6 percent of EU GDP.
  - EDMA proceeds (15 percent GDP issuance) are sufficient to cover such COVID-related debt reductions.
  - Post-COVID mutualization (95th percentile projections): among the five problematic countries, only Italy’s debt is projected to be on a firmly decreasing path after the debt reduction without additional consolidation; Belgium, Finland, France, and Spain still require additional fiscal consolidation.
  - Additional yearly consolidation required under COVID-debt mutualization (to achieve decreasing debt-to-GDP at 95th percentile after 3 years):
    - Belgium: 2.4 percent of GDP (down from 2.7 baseline)
    - Finland: 1.8 percent of GDP (unchanged from baseline)
    - France: 1.8 percent of GDP (down from 2.1 baseline)
    - Italy: 0.0 percent of GDP (down from 0.7 baseline)
    - Spain: 1.3 percent of GDP (down from 1.8 baseline)
- Debt mutualization in proportion to GDP (EDMA issues 15 percent of euro-area GDP and distributes proceeds proportional to individual countries’ GDP, to 10 countries with debt-to-GDP above 60 percent):
  - Results similar to COVID-based mutualization: Italy benefits sufficiently to require no additional consolidation, while Belgium, Finland, France, and Spain still need additional consolidation.
  - Additional yearly consolidation required under GDP-weighted mutualization:
    - Belgium: 2.3 percent of GDP (down from 2.7 baseline)
    - Finland: 1.8 percent of GDP (unchanged)
    - France: 1.7 percent of GDP (down from 2.1 baseline)
    - Italy: 0.0 percent of GDP (down from 0.7 baseline)
    - Spain: 1.3 percent of GDP (down from 1.8 baseline)
- Robustness check: imposing a 50 bp premium on new national debt issuances (to reflect removal of implicit bailout guarantees) erases most improvements in primary balance from the debt operation except for Italy; authors view such a spread increase as conservative.

### Key numerical highlights (preserved exactly)
- EDMA safe issuance capacity: up to about 19 percent of euro area GDP; additional 15 percent of GDP beyond NextGenerationEU (~4 percent) is feasible under baseline assumptions.
- NextGenerationEU debt: nearly 4 percent of euro area GDP (as of 2022).
- COVID-related increase in debt assumed: 10.6 percent of EU GDP.
- Interest-rate sensitivity assumed: interest rate increases by 6 bps for each 1 ppt increase in debt-to-GDP.
- Benchmark sustainability test: debt-to-GDP decreasing after the 3rd year at the 95 percent confidence level.
- Baseline required additional yearly consolidation (95th percentile) for non-decreasing countries:
  - Belgium: 2.7 percent of GDP
  - Finland: 1.8 percent of GDP
  - France: 2.1 percent of GDP
  - Italy: 0.7 percent of GDP
  - Spain: 1.8 percent of GDP
- Required consolidation after COVID mutualization (95th percentile):
  - Belgium: 2.4 percent of GDP
  - Finland: 1.8 percent of GDP
  - France: 1.8 percent of GDP
  - Italy: 0.0 percent of GDP
  - Spain: 1.3 percent of GDP
- Required consolidation after GDP-weighted mutualization (95th percentile):
  - Belgium: 2.3 percent of GDP
  - Finland: 1.8 percent of GDP
  - France: 1.7 percent of GDP
  - Italy: 0.0 percent of GDP
  - Spain: 1.3 percent of GDP

### Lessons from US experience (comparative points)
- Hamilton’s 1790 US debt assumption consolidated state war debts into national debt and accompanied stronger federal fiscal capacity (including exclusive authority to tax international trade); the US later adopted a credible no bailout practice (Congress refused 19th-century bailouts), which supported state-level fiscal rules and discipline.
- Three key differences between US debt assumption and EU proposals:
  1. In the US, state debts assumed were largely for a shared national cause (war); for EU, COVID-related debt is a more natural analogue than pre-union legacy debts.
  2. The US combined assumption with a credible no-bailout constraint and stronger national fiscalization; EU lacks comparable enforcement and ownership structures.
  3. The US assumption was accompanied by nationalization of fiscal policy, whereas the EDMA proposals analyzed keep national fiscal resources unchanged.

### Policy implications and caveats
- Debt mutualization via EDMA could materially improve debt trajectories for some countries (notably Italy) and provide fiscal space for others (Belgium and Spain) but would not substitute for the need for fiscal consolidation and stronger fiscal frameworks.
- Preventing moral hazard is crucial; limiting mutualization to exogenous common shocks (e.g., COVID-19) could reduce political resistance.
- Any serious mutualization proposal must address governance, enforcement of national fiscal discipline, the role of national fiscal councils, potential treaty/legal implications, and banking-union completion to avoid doom-loop scenarios.
- Operational considerations: timing, market liquidity impacts, transmission of monetary policy, and potential ECB offsetting operations require careful design; contingency guarantees and collateral eligibility at the ECB are necessary to preserve EDMA’s safe status in adverse scenarios.
- The analysis is a conservative “zero fiscal resource” feasibility study: it explores how far mutualization can go without national transfers to EDMA; more ambitious designs could assume dedicated fiscal resources or national transfers.

*Italic: Source: WEO Oct 2022 and IMF staff calculations, as presented in the Introduction of wpiea2023059-print-pdf.*

### Conclusions

### Conclusions

### Key findings on mutualization effects
- Under the baseline scenario, for most euro area countries the debt-to-GDP ratio is expected to decrease over the forecast period with 95 percent probability, even without debt mutualization; exceptions are Belgium, Finland, France, Italy, and Spain.
- EDMA can safely absorb up to 15 percent of euro area GDP in debt without jeopardizing its safe debtor status.
- Legacy debt mutualization can help reduce debt levels and enhance public finance sustainability for some euro area countries, but it does not eliminate the need for high-debt countries to maintain high primary surpluses or further increase their primary balance over the forecast horizon.

### Country-specific outcomes and required fiscal adjustments
- Italy:
  - With debt mutualization and policies embedded in current projections, debt-to-GDP would follow a decreasing path after three years.
  - Under the robustness scenario with a 50 bps premium on national debt, Italy’s required constant yearly additional consolidation is 0.0 (percent of GDP).
  - Under the baseline GDP-weighted mutualization, Italy’s required constant yearly additional consolidation is 0.7 (percent of GDP).
- Belgium, Finland, France, Spain (baseline GDP-weighted mutualization):
  - Yearly improvements in the primary-balance-to-GDP ratio equivalent to 2.3, 1.8, 1.7, and 1.3 percent respectively are needed for the debt-to-GDP ratio to be on a decreasing path after three years with 95 percent probability.
  - Under the variant introducing a 50 bps premium on national debt, the constant yearly additional consolidation required (percent of GDP) to place debt-to-GDP on a declining path with high probability are:
    - Belgium: 2.7
    - Finland: 2.2
    - France: 2.1
    - Italy: 0.0
    - Spain: 1.7
- Slovenia:
  - In the 50 bps premium scenario, Slovenia would be part of the group requiring additional fiscal consolidation to feature a decreasing debt path after three years; however, its debt remains below the 60 percent threshold over the forecast horizon, and additional consolidation would not be justified.

### Stochastic-simulation and market-yield considerations
- The assessment emphasizes the importance of accounting for the initial reduction in debt when evaluating mutualization proposals.
- The benefits of the mutualization operation depend on the real rate being lower than the growth rate with sufficiently high probability. Recent tightening of monetary policy has increased real rates, potentially reducing the scope for a self-funded debt issuance; however, higher interest rates and lower growth make debt dynamics less favorable for high-debt countries, which may strengthen the case for mutualization.
- Evidence indicates that debt issued by European supranationals has carried a higher yield than the weighted average of underlying national yields, suggesting an “inconvenience yield”:
  - Possible reasons include supras debt illiquidity and market doubts about continued ECB purchases.
  - The paper argues EDMA debt should be eligible for ECB purchases, without any risk weight, and that properly designed EDMA debt should carry a lower yield than the underlying basket of national yields; the difference (convenience yield on national debt) is central to the analysis.
  - Note: Net purchases of all assets by the ECB (regardless of issuer) were stopped in June 2022. However, going forward, the Eurosystem will maintain the 10 percent allocation to supranational debt (i.e., it can still roll over the maturing ones).

### Fiscal-design and governance considerations
- Mutualization capitalizes a common fiscal resource—the latent appetite for a euro area safe asset—which could fund multiple European-wide objectives (e.g., climate transition, energy sufficiency) but the current analysis focuses on a sound and stable euro area fiscal architecture while keeping consolidated debt levels unchanged when the one-off mutualization occurs.
- Feasibility is not the sole criterion; the question of desirability requires safeguards to ensure national debts remain on sound trajectories after mutualization:
  - Strengthening the credibility of a no-bailout rule is critical; lowering debt levels can reduce bailout probability and improve incentives for fiscal consolidation, but may reduce market discipline if perceived as repeatable.
  - Complementary reforms to contain costs of debt crises should be implemented alongside mutualization (examples given include completing the banking union and imposing concentration limits on banks’ sovereign bond holdings).
  - A proper fiscal framework, as outlined in IMF (2022a), would need to be implemented.
- The debt mutualization operation is not a magic bullet and requires a package of complementary reforms that must be carefully calibrated and implemented.

### Robustness scenarios and effects on safe-asset issuers (Germany)
- To capture a worst-case channel, the analysis assumes EDMA issuance raises German effective interest rate by 100 bps; under this assumption:
  - Debt dynamics in Germany remain qualitatively similar to the baseline projections, and the effects on German public finances are manageable.
  - Tabled projections show German debt-to-GDP estimates and projections (WEO Oct 2022 and IMF staff calculations) for 2022–2028 and a +100 bps scenario, e.g.:
    - Germany: Est. 2022 = 71.1; 2023 = 73.5; 2024 = 72.6; 2025 = 70.8; 2026 = 69.3; 2027 = 68.2; 2028 = 67.0.
    - +100 bps scenario: 2023 = 74.2; 2024 = 74.0; 2025 = 72.8; 2026 = 72.0; 2027 = 71.5; 2028 = 70.9.

### Methodological notes (simulation and thresholds)
- EDMA simulation procedure highlights:
  - Detrend nominal effective interest and growth rates (it, γt) using HP filter with smoother parameter 6.25.
  - Fit cyclical parts to VAR(1).
  - Simulate shocks drawing residuals from a normal distribution with empirical covariance.
  - Use WEO forecast (itWEO, γtWEO) and construct debt-to-GDP dynamics with an interest-sensitivity term where the interest rate is assumed to increase by 6 bps for a 1 ppt increase in debt-to-GDP.
  - WEO forecast extended beyond 2027 by taking 3-year moving averages for forecast variables.
  - The simulation yields threshold d̅EDMA where the 95 percentiles of dt decrease after 3 years.
- Individual-country simulation procedure:
  - Detrend nominal effective interest rate, nominal growth, and primary balance (it, γt, pbt) with HP filter (smoother 6.25).
  - Fit cyclical parts to VAR(1) including lagged primary balance terms.
  - Construct debt dynamics including a nonlinearity term taken from Pamies et al (2021); when adjustment in primary balance is needed, derive a time-constant consolidation amount p̅b by replacing the last term of the debt dynamics with pbtWEO + pbtshock + p̅b.

*Debt Mutualization in the Euro Area: A Quantitative Exploration — Working Paper No. WP/2023/059*

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_Source: https://www.imf.org/-/media/files/publications/wp/2023/english/wpiea2023059-print-pdf.pdf_